ANALYSIS: The perils of a surging trade imbalance with China

Jose Galang -- Your Business

Economic managers of the Duterte administration are turning a blind eye to potentially harmful effects of a ballooning imbalance in the country’s trade with China. Not only is this deficit contributing to the weakness of the Philippine peso, Chinese exports could also further drive inflation which last month jumped to a nearly four-year high.

Even before the much-anticipated deluge of construction materials and machineries from Chinese suppliers to the big-ticket China-financed infrastructure projects that the Duterte government plans to roll out in the coming months, Philippine imports from China surged ahead last year to over $16.83 billion while exports stayed at just $6.91 billion, according to newly released data from the Philippine Statistical Authority (PSA).

This lopsided exchange of goods resulted in a trade deficit for the Philippines of more than $9.92 billion, compared to previous levels of $9.19 billion in 2016 and $5.3 billion in 2015. Imports from China have grown by 47 percent in the three years to 2017, more than 3 times faster than the overall 14.2 percent growth in the Philippines’ imports from all of its trading partners.

The deficit with China last year was 33.3 percent of the Philippines’ total trade shortfall of $29.78 billion for the whole of 2017. It should not be too difficult to surmise how such a large share of the trade gap could impact on the overall economy.

Since the February 9 announcement of the trade data, the Philippine peso has weakened to 51.561 against the US dollar as of the close of trading on February 12, even touching as low as 51.790 at one point within hours after the data release. Analysts see a further drop as imports continue to exceed exports through the next few years, owing to increased procurement of costlier crude oil and infrastructure-related materials and machinery, mostly from China.

The Duterte government’s extravagant infrastructure program, which is expected to entail total costs of up to P9 trillion until 2022, will be financed mainly with Chinese loans. In return, the Philippines has made commitments to use contractors and construction materials and equipment from China for these projects.

While the Duterte economic managers are banking on remittances from Filipinos working abroad and earnings from business process outsourcing operations to prop up the economy’s overall financial transactions with the rest of the world during this period, a fallout from any increase in global interest rates that could be triggered by projected upticks in US central bank rates could spoil that outlook.

The government’s P3.77 trillion budget for this year that aims to achieve a GDP growth of 7-8 percent, assumes an inflation rate of 2-4 percent, a peso exchange rate of 48-50 to the dollar, and a 6-month Libor rate (which banks use as a guide for setting their own lending rates) of 1.5-2.5 percent. The inflation rate in January has already touched the high end of the full-year target range, the target exchange rate has been exceeded, and the Libor rate has risen to 1.99 percent in the first week of February from 1.87 percent a month ago.

These indicators mean that the government may have to spend more to achieve its economic growth target this year. More borrowings could be resorted to, but that would further bloat the national debt burden which at end-2017 stood at a high P6.65 trillion, of which a third was owed to foreign lenders. Alternatively, the economic managers could just make do with a slower growth rate, as it did in 2017.

The possibility that the surging imports from China could drive up the Philippine inflation rate further above 4 percent arises from recent increases in prices of Chinese exports, with prospects of sustained escalation due to rising costs at the production level.

According to newly announced data from the National Bureau of Statistics of China, producer prices of ferrous metals were up by 14.3 percent in January compared to year-ago, non-metallic mineral products were up by 13.4 percent, non-ferrous metals up 10.4 percent, and fabricated metal products up by 5.6 percent.

These are the product categories that registered big increases in import values last year, although the PSA announcement did not provide a breakdown of industrial goods imports by country. These product groups could also be the same items that would go into the infrastructure projects.

Last year, imports of iron and steel expanded by 22.6 percent to $4.07 billion, while those of metal products rose by 19.9 percent to $1.72 billion,non-ferrous metal by 14.9 percent to $1.17 billion, and non-metallic mineral manufactures by 5.3 percent to $1.28 billion.

Local production

In step with the increase in the importation of these products, the local production of similar goods also grew last year, according to PSA data. For instance, the PSA’s volume of production index (VOPI) for basic metals in December was up by 55.1 percent from the year before while that of fabricated metal products rose by 27.2 percent.

However, in terms of net sales, the PSA index for basic metals was up by 34.6 percent while that for fabricated metal products declined by 4.9 percent.

The surge in demand for these construction materials has been exploited by suppliers of substandard products. A statement issued last August by the Philippine Iron and Steel Institute (PISI) said that uncertified reinforcing steel bars (rebars) for concrete structures had been discovered in structures damaged by an earthquake that struck Leyte and Samar provinces that month.

The PISI conducted random purchases from hardware stores in the provinces and after tests, found rebars with “marginal tensile strength”. The group particularly noted the discovery in the market of rebars with a 9-millimeter diameter “which was outside the specifications of government-prescribed mandatory standards”.

The uncertified rebars were said to be imported goods that most likely passed through the Port of Cebu. PISI officials cited news reports of a crackdown on suspected “illegal steel mills” in China that allegedly produced low-quality steel products for construction.